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Earlier this week, on December 7th, 2011, as reported by the San Jose Mercury, the “San Jose City Council votes 6-5 to place pension reform on June ballot.”
This plan is drawing fierce resistance, but there are two financial considerations that most critics of pension reform don’t take sufficiently into account when making their arguments:
(1) Pension contributions are very sensitive to how much the fund can earn. A pension that earns 3% per year, i.e., allows someone who works for 30 years to retire with a pension equivalent to 90% of their final salary, will require a 10% increase in annual required contributions (as a percent of pay) for every 1.0% the earnings on the pension fund drop. That is, if the contribution to a firefighter’s pension is currently 35% per year (based on employer and employee contributions combined), and CalPERS lowers their expected rate of annual return by just 1.0%, from 7.75% to 6.75%, then the required annual contribution as a percent of salary goes up to 45% per year.
(2) The rate of return being currently maintained by most pension funds, 7.75% per year, is much higher than can be sustained going forward. A key reason for this is because equity growth over the past 20-30 years, and especially over the last 10-15 years, was fueled by increasing debt. By enabling massive borrowing – consumer, commercial and government – more consumer spending [...] Read More
When solutions to the challenge to provide retirement security to American citizens in the 21st century are considered, they typically address either social security or public sector pensions, but rarely focus on both of these systems together. But when considered together, as systems that each have unique strengths and weaknesses that might be combined in a single program available to all Americans, options present themselves that might otherwise be ignored.
With both social security and public sector pensions, the challenge of maintaining financial sustainability is dramatically affected by the demographic reality of an aging population. As increasing numbers of people live well into their eighties and nineties, the ratio of workers to retirees edges closer and closer to 1.0.
There are four ways to address the reality of an aging population: (1) Increase withholding from current workers, (2) Increase the retirement age, (3) Lower the level of retirement benefits, and (4) Increase the amount the retirement trust fund can earn. Before delving into each of these further, however, it is important to identify one crucial advantage the USA enjoys vs. virtually all other major developed nations. America, alone among major nations, is projected to have a perfectly even distribution of ages within her population.
AMERICA’S DEMOGRAPHIC ADVANTAGE
America, like all developed nations, has an aging population. But as the four charts below indicate, unlike all other major developed nations, America’s population is replacing itself at an even rate. It is difficult to overstate the serendipity of this phenomena, nor the [...] Read More
A CIV FI post back in January 2010 entitled “Axis of Wall Street & Public Sector Unions” identified an irony still lost on the occupy movement’s rank and file – Wall Street is financed by the pension funds of unionized government workers. Every year, taxpayer funded government agencies pour hundreds of billions of dollars into Wall Street investment funds.
Occupy Wall Street? Why not “occupy” Wall Street’s union paymasters, the government employee pension funds?
Here’s a summary of the dynamics between Wall Street, unionized government workers, and the taxpayer:
(1) The government workers provide services vital to the taxpayer, and charge the taxpayer, on average, about 40% of their income (middle class worker, all taxes – state, federal, social security, medicare, property, sales) to receive these services.
(2) The government workers receive, in addition to their normal pay, funded by these taxes, pensions that are, on average, five times better than what taxpayers get from social security (the average government pension is $60K per year with an average retirement age of 55, the average social security benefit is $15K per year with an average retirement age of 65).
(3) The government workers tell the taxpayers – don’t worry – you don’t have to pay additional taxes for us to get these generous pensions, because we’ll invest the money on Wall Street, and Wall Street will earn 7.75% per year on these investments.
(4) Wall Street invests the taxpayer’s money, funneled through [...] Read More
In less than five years California will have over 10 million residents who are over the age of 55 (ref. U.S. Census, California Demographics). If every one of these people were to receive a pension equivalent to what the average public employee in California can now expect after working full-time for no more than 30 years, it would cost taxpayers nearly $700 billion per year. To put this in perspective, $700 billion is 40% of California’s entire gross domestic product.
When spokespersons for California’s public sector unions claim that pension reformers are “trying to destroy the middle class,” they should be asked this question: How on earth can any system of retirement security – not even including health insurance benefits – possibly expect to consume 40% of the entire economic output of the state or nation in which such benefits are being provided, and yet remain financially sustainable? Universal and equitable retirement security in America will never be realized by offering everyone the deal that public sector employees currently receive. Their benefits must be reduced. But instead, government worker pension funds are making riskier investments.
Public sector pension funds rely on investment returns to make up for the shortfalls in taxpayer revenues. But can investment returns really hope to sustain public sector pensions when there are as many people drawing pensions out of the fund as there are people (and taxpayers) contributing money into the fund? That tipping point, where there is as much money going out as [...] Read More
Today’s Wall Street Journal published an article by Phil Izzo entitled “Bleak News for Americans’ Income,” where, citing U.S. Census Data, it was reported that U.S. median household income – adjusted for inflation – fell by 7% over the past ten years. In constant 2010 dollars, the average household in the U.S. saw their income drop from about $54,000 per year in 2000 to just under $50,000 today.
When debating what level of compensation is appropriate and affordable for public safety personnel, the average income of private sector workers is an important baseline. It provides context for determining whether or not the premium paid to public safety employees – for the risks they take – is exorbitant or fair. The trend of the past ten years is also an important baseline when making this comparison. For example, if the level of risk, the value we place on safety and security, and the degree of training required for public safety personnel have all elevated over the past decade – and they have – does this justify their pay increases exceeding the rate of inflation? Even over this past decade, when ordinary private sector workers have seen their total pay and benefits decrease by 7% relative to inflation?
Here then, also relying on U.S. Census data (ref. 2010 Public Employment and Payroll Data, State Governments, California, and Read More
It is surprisingly difficult to gather data on just how many public safety employees claim disability in their retirements, but this should not prevent us from estimating what the benefits bestowed on disability claimants cost taxpayers.
A common program to compensate public safety workers for job-related disabilities is to grant them a tax exemption, whereby 50% of their retirement pension is exempt from state and federal taxes. While it is virtually impossible to collect data from pension fund administrators on exactly how many retired public safety workers have retired with this benefit, a 2004 investigative report by the Sacramento Bee found that among retired members of the California Highway Patrol, 66% of the rank and file officers, and 82% of the chiefs retired with service disabilities. Similarly, a 2006 investigative report by the San Jose Mercury found that two-thirds of San Jose Firefighters retired with service disabilities. Neither of these reports remain available online, although a Google search on the term “Chief’s Disease” (a term coined by the Sacramento Bee) will find dozens of secondary references to these studies; you can start here, and here.
The point of this analysis, other than to point out the shocking lack of comprehensive data on this issue, is to perform a what-if, based on assumptions that might be reasonably extrapolated from the available data.
The first section of the table below, “Impact per Worker,” shows what a person receiving a service disability tax exemption is really making annually, based [...] Read More
It must be tough for a California state worker to deal with the rising resentment of private sector workers. It must be easy to consider all of this some sort of plot by big business and billionaires to smack down the public sector workers, now that they’ve finished their nefarious beat-down of the private sector workers. There may be comfort in these notions, but little accuracy. Here are some thoughts for our state worker brethren to consider:
The average CalSTRS pension in 2010 for retirees leaving with 30+ years of service was $68,000 per year (ref. Government Worker Understates Average Pension). This benefit is extremely out of line with what is financially feasible. In the competitive, globalized private sector, the ability to retire before age 60 with an income of $68,000 per year requires amassing a huge amount of wealth. When savings accounts are paying interest of less than 1.0%, and the stock markets have been down for over a decade, might you not want to question the assumption that CalSTRS can earn 7.75% per year, long-term?
A self employed person in the private sector who manages to earn over $80K per year pays 53.25% tax on every extra dollar they make – 15% for employer and employee FICA and medicare, 28% federal, and 10.25% state. That doesn’t include property taxes or sales taxes, or the many taxes embedded in the typical utility and telecom bills. And, of course, if they don’t work, [...] Read More
Whenever CalPERS, or any government worker pension fund, suggests that a long-term projected rate of return of 7.75% is realistic and prudent, one needs to consider the following: Across every major stock index in the U.S., and on most indexes in the rest of the world, publicly traded stocks have been down for the last 12 years. Here is a chart of the Dow Jones Industrial Averages staring in January 2000, and running through last week:
What is immediately clear from viewing this chart is that where the index began, nearly 12 years ago, and where it is now, are pretty much the same. To be precise, the Dow entered the week of January 4, 2000 at 11,522, and the Dow entered the week of August 8, 2011 at 11,269 (ref. Yahoo Finance – DJIA 1-2000 to 8-2011). The Dow has actually declined over the past 10.5 years.
Moreover, this loss of equity value should be measured using inflation adjusted dollars, not nominal dollars. If you review the Consumer Price Index from the U.S. Dept. of Labor, you will see that in January 2000 the index stood at 168.8, and in June 2011 (latest figures) the index stood at 225.7. This means that it would take $1.33 today to purchase what $1.00 would have purchased in 2000. From this perspective, the Dow index today would have to stand at 15,406 just to have [...] Read More
The relationship between stagnant economic growth and high levels of total market debt should be clear to anyone trying to manage a household where their home mortgage payment consumes 50% or more of their entire household income. Similarly, the relationship between economic growth and the ability to borrow should be clear to anyone who has enjoyed the ability to purchase anything and everything in sight right up until they reached the point where every credit card they owned was maxed, and every dime of home equity available to them was already borrowed and spent. These comparisons hold true at the macroscopic level as well.
In the case of the federal government, borrowing has been facilitated by the ability to borrow money at cheap rates of interest. According to the official website of the U.S. Treasury, the Total Outstanding Public Debt, i.e., the total amount of money currently owed by the U.S. federal government is $14.3 trillion. From the same source, the Interest Expense on the Debt Outstanding for the first 9 months of fiscal 2011 (through June 2011) is $389 billion, which equates to an annual expense of $519 billion. Does anyone see anything wrong with this picture? The U.S. federal government is only paying interest on its debt at a rate of 3.6%. What happens if this rate of interest goes up?
In the table below, the best case scenario is presented, since it excludes [...] Read More
While much has been made of the impact of pension “spiking,” it is helpful to quantify just exactly how much pension spiking will cost taxpayers, and how ill-prepared an otherwise adequately funded pension account is for this practice. In the two sets of examples below, the same assumptions and the same analytical model is used as in the previous post “What Percent of Payroll Will Keep Pensions Solvent?“; 30 years working, 25 years retired, pay in real dollars doubling between the hire date and the retirement date, and various rates of return.
In this analysis, each block of data has three rows. The first row shows the amount by which the final pay is “spiked,” i.e., increased by a disproportionate amount through a large pay raise, cashing in of accumulated sick time, or other methods that increase pay more than it would ordinarily increase. The second row shows how much would have to be set aside as a percent of payroll each year and contributed into the employee’s pension fund, in order to ensure the fund would have sufficient assets to pay out the calculated retirement pension for 25 years. The third row puts this another way, by showing how much money would need to be in the employee’s pension fund at the time they retire. There are three sets of three rows, representing the results under three different return on investment scenarios; a 4.75% rate of return over the [...] Read More
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